Hidden among the hundreds of provisions in the much-needed omnibus energy bill making its way through the Congress is one that would seriously weaken the competitive natural gas market, increasing volatility and undermining three years of work by all concerned on restructuring and rebuilding that market.
The provision would order or encourage the Federal Energy Regulatory Commission (FERC) to collect and publish purchase and sale information on all natural gas market transactions. It is a directive that was conceived three years ago in a previous energy bill that failed to pass, and it would address a problem that existed at that time and which no longer exists.
Instead, what the provision is likely to do is drive active traders to the sidelines, once again undermining the market’s ability to set prices, and creating new uncertainties for the industry and consumers alike in this very basic energy market.
The supposed problem the provision would address no longer exists because the industry, FERC, and the publishers of those price surveys, including Natural Gas Intelligence (NGI), have put in hundreds of man-hours of work since that time revamping the privately-run process of surveying gas market transactions.
It no longer exists also because in the intervening time, the Commodity Futures Trading Commission (CFTC), FERC and various U.S. attorneys across the country have aggressively pursued price manipulators from the overheated market of the Enron era. Hundreds of millions of dollars in fines have been collected and a number of traders have been led away in handcuffs as a result of these investigations. It should be noted that all the investigations have been of actions that took place in the 2000-2002 time period. None have been directed for any time period after that, indicating an object lesson learned.
In short, government and industry have cooperated in cleaning up the price survey process, weeding out the transgressors and setting a new course based on FERC’s guidelines and backed by new laws and penalties (in the current energy bill) against would-be manipulators.
FERC directed the restructuring process, generating numerous conferences, reports, and surveys, culminating in a policy statement in July 2003 setting out new guidelines for market participants and price publishers alike.
It continued to refine and monitor the process to the point where it was able to state late last year: “In the 15 months since the issuance of the Policy Statement, significant changes have taken place in the existing voluntary system of providing transaction data to multiple index developers. The record shows a steady increase in the number of companies reporting their transactions, and a substantial improvement in the systems by which prices are reported” (PL03-3-005, Nov. 19, 2004).
Having laid out four options for possible further action and requested comments, FERC noted in its November order that the “majority of commenters urge us not to initiate steps toward mandatory reporting.Most participants favor the present system of voluntary reporting and multiple index developers, and urge continued monitoring of developments and more voluntary price reporting.”
In that order, the Commission determined it would take no action toward a mandatory price reporting system or centralized data collection. Instead it would remain vigilant and continue monitoring the existing voluntary reporting system.
“This monitoring can best be accomplished as part of the Commission’s ongoing oversight of competitive energy markets. Staff is directed to continue to monitor the level and quality of reporting to index developers and the adherence by price reporting entities to the standards of the Policy Statement, as well as the quality of price indices and the adherence of price developers to the standards of the Policy Statement. Trade associations and index developers are encouraged to assist staff in this monitoring. Staff should include an evaluation of the accuracy, reliability and transparency of price formation in the next State of the Markets Report or other timely report.”
What has cooperatively been built is a much better and stronger system, with broad participation, clear rules, procedures and penalties; and it works. Government has provided the leverage that price publishers previously lacked, effectively leaning on companies to participate in the voluntary survey and to do so in a prescribed format with company executives accountable. FERC also has pressured the price publishers to provide more back-up information for the indexes they publish, giving market participants a better idea of the volumes and transactions behind each index.
Right now, due to the combined efforts of FERC, the industry and customers and the price publishers, at least two publishers, NGI and Platts, have the voluntary cooperation of almost all the major market participants in their price index surveys under the new rules and conditions.
The natural gas market has come back from the brink. Few will ever really know how close it came to collapsing, but the numbers give some indication. In November 2002 NGI’s monthly indexes for bidweek or baseload transactions were based on reported survey volumes of 3.9 million MMBtu/d in 435 transactions, the lowest participation in the last 15 years of price surveys. Platts, the other major publisher of natural gas price indexes, reported 4.9 million MMBtu/d in 540 transactions.
The decline occurred partly because the mega-marketers, under financial and legal pressures, got out or were run out of the business, and partly because the remaining participants, fearful of becoming involved, moved to the sidelines, choosing to index or not report. The lack of reported market liquidity caused extreme price volatility.
Restructuring efforts have paid off. In the latest survey for June 2005 bidweek or baseload, NGI’s indexes were based on 21.2 million MMBtu/d and 3,069 transactions. Platts’ June 2005 baseload indexes were backed by 23.018 million MMBtu/d and 3,387 transactions. The progress is recorded in data made available every month on the website https://www.naturalgas.org/business/marketactivity.asp
If FERC were authorized to survey gas prices, NGI fears this would once again suddenly and seriously diminish the price data available to the published surveys, as trading companies reevaluate strategies and move away from fixed price trading to what they perceive as the “safe haven” of indexing.
As it stands now some companies in the market choose to index their transactions to either the New York Mercantile Exchange or to the published indexes. One of their reasons for doing that is the belief and the reality that a government body or a stockholders’ board of directors is unlikely to question the price, since an index represents the market price.
In any after-the-fact investigations the use of an index is eminently defensible, while doing a deal at a bilaterally-negotiated price must be explained and might be condemned and invalidated, or worse. Market participants are extremely edgy and react quickly to perceived dangers; witness the not so funny joke making the rounds that has company lawyers advising operating personnel about transactions, “if it will make money, don’t do it.”
Unfortunately, if everyone indexes and very few do fixed price transactions, there will be no information on which to base the indexes and therefore no indexes – no matter who collects the data. During the down period in 2002, the fixed price market was very thin, it was extremely difficult to collect enough transaction information and many locations went without indexes, causing severe billing and payment problems for some companies which indexed.
The price transparency provision in the energy bill would give FERC the responsibility for collecting price information from everyone in the market and making the resulting aggregated information public. The legislation includes only token language protecting the confidentiality of companies’ individual transaction information.
Note that on its face, the bill’s language appears to protect the autonomy of price publishers, but our price reporting business still stands or falls on our ability to accurately report on a functioning market, and, as written, the bill would jeopardize that.
Under the guise of adding transparency to the market, the Congress would, in fact, seriously disrupt and weaken that market. Either the House or Senate version would be almost equally devastating. The House bill orders FERC to assume responsibility for surveying prices. The Senate measure says FERC “may” set up a price collection process. The problem with the latter is that it appears to be discretionary, but the Commission in the future would have to answer to Congress as to why it did or did not choose to act. The language contains nothing to give FERC direction in making that decision, so the agency to protect itself from future recriminations “may” be forced to install a government-directed price collection process.
What will happen if this directive is passed into law? Fixed price transactions would become scarce as companies chose to stay on the indexing sidelines rather than report bilateral transactions to FERC. It is axiomatic that if there are no fixed price transactions, there is no market price to discover. Government could be forced to step in and set prices in order to calm an unstable market.
This would be a worst case, but even a best case under a new mandate would see some companies exiting active trading. The market would become less liquid, hence more unstable, and the process we all have worked so hard to rebuild would be undermined.
The Congress will have one more crack at the price “transparency” language in a conference committee on the House and Senate versions of the energy bill which is expected to follow soon after Senate passage, and it is possible there could be moderating changes, if the conference members can be apprised of the current market status.
Making the law clear and giving FERC increased penalty powers should be enough to keep the new “voluntary with FERC guidelines” system on track. The energy bill also could require FERC to continue to actively monitor market activity and reporting, possibly with periodic conferences (bringing everyone face-to-face has been helpful), and keep the pressure on with surveys of who is participating and who is not. Plus, the Commission could continue with its practice of investigating apparent market aberrations. Also, FERC could be directed to work with the Energy Information Administration on making available as much timely information as possible on demand, production and storage. The Commission, while lamenting the lack of fundamental market information, necessarily has deferred to EIA in that regard and EIA’s imperatives are not the same.
The industry, government and the publishers are wrapping up a bad period in the growth of the competitive natural gas market, a market which began just 25 years ago. All need to remain vigilant, but to drive us all once again into rewriting the rules, at best would cause a serious disruption; at worst it could be disastrous.
Natural Gas Intelligence
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